3 charts for your Friday consideration

* In the end, much of what we see flickering on our screens comes down to trends in real interest rates. While it feels like the recent fixed income sell-off has left yields at their highest levels in many years, in reality the level of US 10y yields is still some 50 bps lower than that at which it ended 2013. Real 10y yields, meanwhile, are back to their close to their peaks of the post QE-infinity era. It certainly feels as if the prevailing narrative supports a breakout, both in terms of the direction of fiscal policy and the reaction function of monetary policy. Such a development would almost certainly have consequences for a range of financial and hard assets; as you can see, the relationship between real yields and gold has been fairly strong over an extended period of time.

* Although developments in UK Brexit policy haven't warranted much confidence, sterling has weathered the storm of recent dollar strength fairly well, on balance. This has perhaps been a function both of an embedded short base and the BOE's "limited tolerance" for inflation overshoots, which stylistically at least presents a less dovish alternative to the Old Laday's cousin in Frankfurt. That being said, the rally bore all the hallmarks of a correction, and that correction now appears to be over, as the chart broke as neat a little uptrend support line as you're likely to see today.

* The China FX fix made a new high last night at 6.95080. At this rate it won't be long before we're on a 7 handle; when that happens, perhaps the US president-elect will start a permanent WhatsApp chat with his BFF in Taiwan. One can imagine that capital is queuing up to leave the country post-haste. But here's the thing: you have to imagine it, because currently the ancillary evidence isn't great in the currency market. Historically, the CNH has traded at a discount to the onshore CNY during times of financial duress, when capital outflows tend to accelerate. For the time being, not only has the discount not widened, but the CNH is actually trading at a tiny premium to the onshore CNY! Perhaps this is a function of the authorities intervening in USD/CNH; indeed, front end rates are squeezing higher, which would fit that narrative. Even so, they've been quite a bit more effective than has previously been the case. Either way, keep an eye on the spread for clues as to when the China narrative will go global again.

Same here, never seen such a move... if the spx proves to be similar, it's really worth positioning at silly levels for a fade on monday... i'm currently at 3285 and 3300 on sx5e cash, and 2283 on spx, it's just been parabolic recently, and santa is not that generous, bless him...jd

"Mario Draghi warned European leaders that the combination of rising global interest rates and explosive politics could expose the euro area’s underlying weaknesses, even as he painted an upbeat picture of the region’s recovery."

"Even so, Draghi said 2017 was fraught with risk as the full impact of Brexit and of Donald Trump’s election in the U.S. is yet to show. A rise in interest rates could put renewed pressure on countries with high debt that have failed to consolidate their budgets, he said. This stress could spread to the whole region as economic differences across countries have increased and structural reforms have ground to a halt."

In other words, EU is toast. The only ones who don't realize it are the completely out-of-reality Brussels ivory tower fat cats.

The pace of foreign selling of US Treasuries continued in October at a sharp pace. Foreigners sold a net $63.5b of notes and bonds and brings the year to date amount of liquidation to $321b. China continued its selling, by $25.7b and brings the last 5 months of selling to $109b. We know the reasons. Japan continued its selling too, by another $16.1b but they are now the largest foreign holder of US Treasuries, surpassing China. Europe was also net sellers of notes and bonds. Outside of China that has its own internal reasons for their selling, the spread pick up of buying US Treasuries has disappeared because of the high cost of hedging out the FX risk.

Bottom line, foreign selling of US Treasuries is not new as it’s been going on since 2015 but the pace has really accelerated over the past 7 months with China leading the way as they see their reserves shrink. This has been a factor in my bear case on bonds and I don’t see this reversing anytime soon.

In 2015 when the rotation into 'safe dollar' assets was in full swing, we used to observe that whenever the dollar pulled back from all time highs, equities went sideways or up and bonds sold off because thats where the money had gone. Are there any guesses about where the money has gone in the last 2 months?

I think a reversal in bonds boils down to JPY at this point. I suppose USDJPY could make it to 120, at which point the Chinese freak out a little bit. The fact that our President elect (or better still, his daughter) is interested in whispering sweet nothings into the Japanese PM's ears while all but toilet-papering the Chinese premiere's lawn probably doesn't help either.

"I think a reversal in bonds boils down to JPY at this point. I suppose USDJPY could make it to 120, at which point the Chinese freak out a little bit. The fact that our President elect (or better still, his daughter) is interested in whispering sweet nothings into the Japanese PM's ears while all but toilet-papering the Chinese premiere's lawn probably doesn't help either."

I agree with this WasheUp! I am not sure your rationale is right ;), but I definitely think we need to see these major FX pairs hit the skids a bit for the recent "trends" to reverse. Stocks look tired indeed Nico, but also sticky. Shorting is heavy sledding here!

Nico's just talking his (losing) book. He likes to sell things that are going up - I guess it's egotism (wanting to be proved right). Anyway he fails to learn some very expensive lessons. For the new traders here, I strongly suggest you ignore him, or better still fade his trades.

1) be my guest anon 5:55, let's cross 100 Eminis now together if you can afford it

2) about the pound, i told you GBP was the currency of Kings

the pound has gone full waterski behind the dollar powerboat and is in the process of slowly regaining all that it lost against the euro. I've always said that ultra-liberal UK was always 100 times better than the King Crimson sorry, the Crippled Kingdom of Brussels and Unelected Eurocrats. Hence the dip post Brexit was a gift by the Kings, to us plebeians

3) one last word about EQUITIES before the week end

grandpa can't but distill words of caution to our younger crowd here. Yes you, the anon pricks. You need to remember how they try to maintain unrealistic valuations last December, all the way to the bonus fixing, amid the first warning and the first rate hike from the Fed. First signs of crack came between Christmas and New Year, they still managed to 'fix' their year performance but they had to let it go after that and boy, how hard down it went from first day of the year

i see the exact same pattern here, only worse. When you could buy the dip last January/February knowing that the Fed would not nuke the market on election year, i doubt we will feel the same comfort knowing Yellen is on a war path sorry, on a Democrat-ic mission to do her job right. And fuck Trump over.

I see smart money exiting here while they tell you it's all about inauguration date, sell the news blablablah. It can't be that naive. To me the market goes hard down once again early January and will leave all the late bulls dead in their tracks. So grandpa wanted to make sure that noone from the MM possee would be reckless enough to not sell his longs before year end. You've been warned, rates are going up everywhere in the world, it's gonna nuke Asia, it will nuke Europe for sure, and it will complicate matters in $20tm 'Mehrica

****

Raising rates gave a strong bid on banks which is how equity managers save the year. That is all nice and cute, but raising rates/bond losses will have horrid consequences on European banks to start with. They did a great dead cat bounce before they have to mark their GIGANTIC bond holdings to market sometimes next year when Draghi urges them to. Deutsche Bank, we are (still) watching.

So this is how i see it, a monster rotation into laggard banks, new highs on all US indices, Europe back to flat on the year, and then the most volatile 2017 one could fear. Do NOT expect the Fed to be cute with the Trump rally. The Fed put is gone and after 7 years of Pavlovian market it sure takes a while to sink in. Get out during that golden window (of dissonance).

Full respect Nico. I like your bear talk. I was bullish the last whole year and it's nice having someone putting things in perspective from time to time to not get blown away into bullish wonderland. Same reason why I read Zerohedge occasionally and not just this blog.

Fwiw, I'm reducing long positions. Did so too early but you never get the timing right 100%. Had a great 2016 trading. Thank you all, especially the master himself MM of course.

I take it personally when it's addressed to my name ;) Differences we shall have, absolutely, but with humour perhaps, not that lame, lousy 4th grade rap hidden behind an anonymous screen.

when Spoos were limit down after Trump elections, or in June when Estoxx futures opened -12% after Brexit grandpa was on the right side, covering gigantic short trades. Cashed in seven figures twice but did not rub it in anyone's face here or worse, mocked the ones in great pain on the other side of the trade

the 8-12 year old anon crap always come at new highs, precisely when they should be careful. MM should patent that brand new effective indicator, the MM12 oscillator, boolean, silent/annoying modes.

UVV seized and the 10Y trades down 5bps. These (what I'd call minor) geopolitical events are usually a fade. We'll see ... I'm already aggressively short duration, so this is someone else's trade to do.

Nico, thank you for your thoughts. Always good to hear your market views here. And re yesterday's thread, I'm glad you made money off USDCAD earlier this year. It was a great setup. Oil bottoming. Everyone turbo short CAD. Canadians thinking their currency was going to converge to Toilet Paper Parity. And expectations that the BoC was going to cut to negative rates (when they were essentially saying they were holding that in reserve for a nationwide housing crash) and cause an out-of-control crash in their currency (which is not what central bankers do when their currency has already crashed and is trading two sigma cheap to drivers). It was so beautiful.

Re markets, I am working with a different template. I'm thinking back to Abenomics, where the yen sold off and Nikkei rallied through the 2012 holidays, relentlessly (I wanted some time off before re-engaging with markets in the New Year, and I remembered checking the yen every day and being p1ssed off I wasn't in the trade). Trumponomics is a huge shock, arguably of similar magnitude to Abenomics, so I'm thinking it's possible we have continued re-positioning in lightly attended markets pushing trends further. It just seems really hard for me to known Trump-catalyzed flows are going to subside (relative to available liquidity to accommodate them).

Abe had his puppet Kuroda working FOR him not against him. Abe had a weak JPY working FOR him not against him. Huge differences, Trump has to deal with adverse monetary policy + a currency nightmare that he was so strongly campaining against (the cheat devaluers everywhere)

sorry, did i forget to mention that Abe erupted amid a depressed economy and depressed stock valuations. Trump arrived at all time high valuations after 7 years of bull market, isn't it one tad greedy to expect 1/2 years of additional bull 'just because'

Nico, I hear you re the starting point for stocks in Japan in '12 versus US in '16. A good point.

Re the Fed, I think they're going to try not to appear so political, seeing that Trump and the Republicans are looking for any excuse to take away the institution's independence. I mentioned yesterday that what I think is Yellen's dot did not move. She's going to be very careful not to look like she's applying a double standard. I think everyone got a bit carried away, over-interpreting the dots and Yellen's presser, and I'd be looking for steepening from here.

The other point I'd make is that Trump is a game changer for the stimulus that really matters -- fiscal, not monetary. The backdrop is that we've all been questioning the effectiveness of incremental monetary policy, e.g. "is the Fed out of bullets?" That left fiscal policy as the only lever to prevent a recession, but with a Democrat executive and Republican congress, no fiscal stimulus was likely until after the recession hit. Now you can expect the government to act swiftly if there are signs of a recession. Cutting that perceived tail risk by itself is worth something. Taking on board your comment on stock valuations however, I like the trade advocated by Global Macro Speculator (https://globalmacrotrading.wordpress.com) of going long US levered loans, especially after the Saudi comments this weekend which should support oil.

I think fiscal is more effective than monetary stimulus, at least for the real economy. Fiscal stimulus pushes money into the hands of those who spend it in the real economy. Monetary policy, when stuck at the zero bound and having to resort to QE, just puts money into the financial system. That could be very helpful if we're in circumstances where there isn't enough money in the system for debts to get rolled, but otherwise the wealth effect is small, it feeds inequality/angst, and makes people save twice as hard.

I guess my point is that I don't see rates going up quickly, even with fiscal stimulus. Trump's election has cut the recession risk for the next years, which was high before he was elected (we're far into this expansion, in # of years). Cutting that tail risk makes equities a more attractive asset class, especially when the alternative is fixed income, which is going into a bear market. I read that the stock market has never topped more than 13 months before a recession ... so the fact that a possible recession has been pushed out is a big deal when your alternative is low-yielding bonds with a strong duration headwind.

@johno "Trump is a game changer for the stimulus that really matters "

Seriously? Trump is a game changer for exactly nothing, as his cabinet appointments have shown - as for fiscal policy, anything of material significance has never happened in the US without the powers that be getting hit on the face by a frying pan (remember the 2001 tax cuts? Took sep 11 and spoos taking a 50% beating to get those done, and that was not a divided congress - remember TARP? oh only the entire financial system coming unglued and Paulsen willing to blow Pelosi).

This is hope - pure and simple - nothing wrong with it and everyone is entitled to it. You want to trade it from the long side, great - just know what you are long, and hope there will be greater fools around in the next few months willing to take it from you.

Washed -- good points re 2001 and 2008 fiscal stimuli. The idea that a timely counter-cyclical stimulus could avert recession is probably more perception than reality (of course, there's likely to be some pro-cyclical stimulus coming next year, so pushing out a recession).

I do think Trump is possibly a game-changer. His cabinet appointments are SO pro-business (the CEO of XOM as SoS, seriously?? Wilbur Ross as SoC, seriously??) ... before Nov 8, anyone doing anything with a profit motive had worry to Elizabeth Warren and her ilk were going to come after them on charges of breathing. Breathing! It's a huge boost to confidence, which we've already seen in survey #s. Still, Trump will likely fail to deliver on most promises, but then, so did Abe, and the Abe trade was a HUGE winner.

Of course, Elizabeth Warren and her kind had no problem with techies motivated by "changing the world" (not profits, never profits!), whose new technologies obliterate whole swathes of middle class jobs and undermine people's sense of economic security. Meanwhile, the Democrats think they lost because of Russian hacking, or whatever. Clueless.

Johno interesting comments about trump stimulus. While I agree with washed in terms of implementation, if trump comes out swinging early in his term, business confidence can probably improve in the U.S. But higher rates, higher USD and higher commodity prices will bite at some point. Perhaps not the US consumer or even U.S. corporate if we get improved growth ( I won't bet but market sure is). But someone around the world will get lit up. That is almost a sure thing and the more we push I think we just increase the odds of something happening.

The markets today are increasingly model driven. Especially with short term flows. Like LB said yesterday we are not going to see a YC inversion, which is a big red flag for almost any model, so for the time being we party on, with the citi surprise index and easy yoy earnings comparisons. But surprises almost always mean revert. Q1 has been weak for who knows how many years so maybe yoy comparisons ok next year. But after that I wonder. Cyclical stocks go up and down fast. And if rates don't blink on the first equity move lower, there will be no place to hide for equities and even if rates do go lower the safety trade in stocks doesn't have the same momentum as last year. Long story short equity markets, while riding high are very vulnerable here, even if headline index looks ok.

i still like the U.S. Housing sector as a secular trade but cutting positions here. Will look to buy a good 30% lower when ppl panicking.

@abee - "re: And if rates don't blink on the first equity move lower,"

And that is precisely the next thing that is about to happen (assuming of course, that equities ever turn lower!) - I think if people start thinking of 2.3-2.4 on the 10 Yr as a new floor instead of as a ceiling, a lot of carefully constructed portfolios suddenly start to suck - except these are mammoth positions. Far from dragging US rates lower, rising rates may actually start to drag yields up in eurozone and japan.

Not possible because of QE over there you say? Wrong - the Fed was buying these things hand over fist in 2012-2013 and the 10 yr went up 150 bps because people would have rather owned riskier stuff. The backdrop then was benign, but just remember for the last 2 years people have owned bonds for capital gains and stocks for income!

The biggest irony here is that people are talking about rates staying low or going up around actual inflation - treat it for what it is, a paper trade with extremely crowded positioning which could have a long, long way to go - trust me if the 10 yr went to 3.5 or 4 because of portfolio unwinding a new narrative would be invented to explain why thats fine and dandy. When TLT was at 143 it reminded me of crude at 140 in july 08 - right now it smells like crude at 85-90 in oct 08 - the only reason it feels like a big correction is because of recency bias.

I really, really hope we get a short squeeze in bonds that I can sell into (and so our pal LB can get paid) - I am beginning to think I may not get a chance.

MM, very timely post! Got me thinking, the good ole trusted fear gauge toolbox is shrinking due to govt and cb tinkering: usd/jpy, sovereign bond yields, ted spread, are all rendered useless now. We still have vix though and I think it's about to pop. Today's exp skewed things quite a bit and vix sub 13 is a gift here, imho. We just lost the parachute at 20K ft (Dow pun totally intended). Yellen just told the bond vigilantes the ball is theirs to keep. This time though the weird thing may happen: bonds and stocks may just dance together and go down in tandem with no meaningful rotation. Think about it... Most of the large foreign sellers (huge position holders) of US treasuries would not rotate into US equities, especially the Chinese. First, they take our water toys away (South China Sea drone), next they will freeze our refi market (house is our most valuable asset!), last they will tell our companies to leave as a result of a trade war. This is a scary path, and vix is still below 13? Donald the Duck will quack their way and they (shameless currency manipulators, lol) will unleash the deval. The effects would probably last far longer than the last summer.

I am easing into put spreads on transports, semis, copper, and very small regional banks. I believe the rotation would be out of cyclicals into utilities and staples. Players (especially the yield chasers who would be afraid of stepping in front of a freight train in falling treasuries) would hide in those sectors from the wrath of a runaway dollar and policy uncertainty. I am still long (extremely trimmed position) some US shale producers as WTI is doing its last dance above $50. Will dump on uncivil anons :) Aren't they the greatest fear indicator (FOMO) we still have?

"Blogger Nico G said...PS: of course i am talking my book/ short SP @ 2228 and now short Estoxx (it had been a long time) @ 3360"

I would like to advise you not to pursue this policy. Shorting EU Banks and EuroSTOXX will not work well.

You should be aware that among other things, plans are in progress to agree state support for Italian banks, and the ECB will treat this as a 'one-off expense', which will not affect Italy's structural deficit measures, and thus be allowable by the ECB.

In addition ECB are purchasing corporate bonds of a number of large multinationals. The program and companies in question are not public knowledge, nor is the fact that many of these bonds are purchased via 'private-placements'. This has the effect of providing massive cheap funding to large EU corporations and indirectly boosting their equity prices. It also makes the ECB a large 'silent partner' in many EU multinationals, who cannot allow these equity prices to fall too far. A similar situation to BOJ, which conducts equity purchases directly, and has become a dominant player in Japanese equity markets.

(the Estoxx short is an expiry trade to be closed Monday or Tuesday, i wrote last July that Europe would outperform the US fron then on)

the Spoos short is another, deeper story and I think Caterpillar stock will not like the last appointment of Mr. MULVANEY:

“Mick is a great choice to lead the O.M.B.,” Mr. Scott said on Saturday. “We entered Congress together in 2010, and I am certain he will tackle his new position with the same passion he has represented the Fifth District with over the past six years. Facing a $20 trillion debt, we need someone committed to restoring fiscal sanity in Washington, and I am confident Mick will work to do so.”

As budget director, Mr. Mulvaney would help guide a repeal of the Affordable Care Act — a promise of the president-elect — a tax overhaul and, potentially, a huge federal investment in the nation’s infrastructure, which, like many Republicans, he does not want.

I am convinced from day one that Trump is going to make US economy remarkably efficient which is BAD for equities - the chase for wasted budget ressources, oversized, overbilled projects will force companies to trim their profits and if things were not clear yet (obviously not, the equity market is completely mistaken) then the appointment of Mulvaney the spending hard-liner, completely opposed to infrastructure spending, should finally ring the bell

I doubt Santa can fight both this anti=spending force, and a restrictive Fed so IMO Spoos have already topped.

Yes, Nico. Very interesting appointment. From what little I've read, he seems to buy into Laffer Curve arguments of offsetting growth-driven revenues from tax cuts. On the other hand, in November he said infrastructure spending shouldn't add to deficits. Certainly makes any infrastructure-themed trades less interesting, at the very least.

bonds are a separate story and i do think the downtrend is here to stay

my take on equity markets is that the tape has taken everyone by speed since Election's limit down. You had to be so fast 'buy now, think later' - which most people can't do especially when momentum initiates when they sleep - to jump on the momo bandwagon when technically, in the regular trading hours of November 9th, a speculator would wait for a retest of overnight low, or a higher low but tape just ripped up and never look back.

that's phase one

i think we are now entering phase two when players need to assess markets levels in light of cabinet appointments and the Fed's last stance which are FACTS and are starting to give a picture of the reality to come, after the 'cult' move up based on euphoria and no fact at all. If you are not in the market, you can't be chasing the rally here after 150 handles of unwarranted euphoria. If you are long on the election swing you want to ponder how much more Santa can deliver and think of taking profits.

as for the shorts well, there is almost noone who would fade euphoria in their right mind, which makes it for a very interested play. Short Spoo is probably the least crowded trade we've seen in years. Some laymen friends who played the market in early 2000, and in late 2007, some of whom puked early 2009, are finally writing asking if they should get back in seeing Trump blablah. To me this is the saddest contrarian indicator of all.

I imagine you are referring to US treasuries. I am in your camp and looking for a test of 115 on TLT. I think it would be a good area for a quick counter-trend trade, a bear market rally (115 is exactly 20% off the top and is last year's low). I think it may be front ran by traders so I am ready to pull the trigger a bit sooner and will play it via call spreads. I think the price will attempt to backtest a broken uptrend channel first, then proceed to backtest the horizontal level breaks at 118, 120, 123-124, and even 127 area. Pretty crazy to expect it considering the game has changed from the Fed's perspective, but bear market rallies are sharp and vicious, mostly unexpected. The momentum is scraping the floor on all longer term time frames here, but one can stay embedded in the oversold for a while. I will switch to shorter term charts to fine-tune the entry once we approach the big level.

My apologies in advance if many here are not into charts. I hope this helps...